FINANCIAL SYSTEM

In economics, a financial market is a In finance, financial markets facilitates

mechanism that allows people to easily buy
& sell financial securities (such as stock &
bonds), commodities (such as precious metal
or agricultural goods) & other fungible items
of value at low transaction costs at
predetermined or market determined prices.
breeding of capital through capital markets,
transferring and minimising of risk (in the
derivative markets), and international trade
and are used to match those who want
capital to those who have it.

Sub types of financial markets are:

1. Capital markets comprises of stock markets and bond markets.
2. Commodity markets – which facilitates the trading of commodities.
3. Money markets – which provide short term debt financing and investment.
4. Future markets – which provides standardized forward contracts for trading products at
some future date.
5. Derivative markets – which provide instruments for the management of financial risk.
6. Insurance markets – which facilitates the redistribution of various risks,
7. Foreign exchange markets – which facilitates the trading of foreign exchange.

Capital Markets:
Capital market is a market that facilitates companies and enterprises in raising
income by mobilizing the savings of individuals, corporate houses and other lenders. It helps
companies to in raising long term investment credit. There are two types of capital markets;
a. Gilt Edged or Government Securities Market: In this market government securities
issued by Central & State Government securities that are guaranteed by Government. E.g
municipal bonds or local government securities. These securities are backed by RBI.
There is low risk involved in it and they can be easily sold at the prevailing market price.
The securities are of stable value and are much sought by banks etc. The RBI also
conducts its open market operations for controlling money supply in market through
these securities. E.g is savings through post office, small savings schemes, public
provident fund, and treasury bills.
b. Industrial Securities Market: It is market for shares and debentures of old (stock
market) and new companies (primary market). A stock market is a private or public
market for trading of company stock and derivatives of a company stock at an agreed
price. Stock market or exchange is a corporation which provides facilities for the issue
and redemption of the securities as well as other financial instruments and capital events,
including payment of interest and dividend. To be able to trade a security on a certain
 exchange, it has to be listed there. Oldest stock exchange in Asia is BSE-Bombay Stock
Exchange (est. in 1875) with 133 yrs of existence.
NSE-National Stock Exchange India’s leading stock exchange started trading in equities on
November 3, 1994. It became first exchange to launch trading in options on individual from July
2, 2001.

Derivative Markets:
Derivatives are financial instruments whose value changes in response to
changes in underlying variables. The main types of derivatives are:
a. Forward: The forward contract is an agreement between two parties to buy or sell an
asset at a specified point of time in future. The price of the asset is paid before control
over asset changes. Spot price is the price at which the asset changes hands on the spot
date. The difference between the both is the forward premium or forward discount.
b. Options: Options are financial instrument that convey the right but not the obligation to
engage in a future transaction on same underlying security. Holder does not have right to
exercise this right, unlike the forward and future.
c. Future: A future contract has the same general features as a forward contract but is
transacted through a future exchange. Future exchanges trade in standardized derivative
contracts. There are option contracts and future contracts on a whole range of underlying
products. The members of exchange hold position with these contracts with the exchange,
who acts as a central counterparty. When one party goes long(buys) a future contract,
another goes short(sells). When new contract is introduced, the total position in the
contract is zero. Therefore sum of all long positions must be equal to all short positions.
In other words, risk is transferred from one party to another.
d. Swaps: A swap is a derivative in which two counterparties agree to exchange one stream
of cash flows against another stream. These streams are called legs of the swap. The cash
flows are calculated over a notional principal amount, which is usually not exchanged
between counterparties. Consequently, swaps can be used to create unfunded exposures
to an underlying asset, since counterparties can earn profit or loss from movement in
price without having to post notional amount in cash or collateral. There are 5 types of
swaps: - interest rate swaps, currency swaps, credit swaps, commodity swaps & equity
swaps.

Commodity Markets:
Commodity markets are markets where raw or primary products are
exchanged. These raw commodities are traded on regulated commodities exchanges, in which
they are bought and sold in standardized contracts.
a. Forward contracts: A forward contract is an agreement between two parties to exchange
at some fixed future date a given quantity of commodity for a price defined today. The
fixed price today is known as forward price.
b. Future contracts: A future contract has the same general feature as a forward contract
but is transacted through a Future Exchange.
c. Spot Trading; Spot trading is any transaction where delivery either takes place
immediately, or with a minimum lag between the trade and delivery due to technical
constraints.
d. Hedging: “Hedging”, a common practice of farming cooperatives, insures against a poor
harvest by purchasing future contracts in the same commodity. If the cooperative has
significantly less of its product to sell due to bad weather or insects, it makes up for that
loss with a profit on the markets, since the overall supply of the crop is short everywhere
that suffered the same conditions.
e. Paper Trading: Paper trading (sometimes known as “virtual stock trading”) is a
simulated trading process in which would-be investors can ‘practice’ investing without
committing real money. This is done by manipulation of imaginary money and
investment positions that behave in a manner similar to the real market.